STATE TAX INCENTIVES AND SUBSIDIES TO BUSINESS

One significant impetus behind the constitutional convention of 1787 was concern over what Justice benjamin n. cardozo described in Baldwin v. G. A. F. Seeling, Inc. (1935) as "the mutual jealousies and aggressions of the States, taking form in customs barriers and other economic retaliation." Among the weapons deployed by the Framers against this destructive economic rivalry was the commerce clause, which the Supreme Court has consistently interpreted not only as a grant of power to Congress but also as a constraint on the authority of the states to interfere with the free flow of interstate economic activity.

In the latter part of the twentieth century, analogous interstate economic rivalry has resurfaced in the form of the proliferating use by states of tax incentives and subsidies to compete for business investment and jobs. This interstate competition has spawned a wide array of tools designed to attract businesses, ranging from property tax abatements to loan guarantees, and from investment tax credits to preferential methods of measuring taxable income. The competition has led to nationwide replication of many of these policies, and benefit packages offered to attract large new facilities often measure in the hundreds of millions of dollars. Business tax incentives have contributed substantially in many states to a sharp decline in business taxation's share of state revenues.

The question of whether state tax policies and incentives significantly influence business decisions about where to locate remains the subject of heated debate among the economists who study such issues. But there is little doubt that whatever influence these policies may exert affects only the location, and not the overall national magnitude, of business activity. The primary effects of the incentive competition are the depletion of state resources, the reduction of costs for mobile businesses, and the distortion of economic decisions away from the most efficient distribution of business investment. Nonetheless, no state can afford the political and economic risks of withdrawing from the competition while its neighbors continue.

The commerce clause offers a possible restraint on the interstate competition over business tax incentives and subsidies. In a long line of cases, the Court has found that state policies, and especially state tax policies, which discriminate against out-of-state or interstate economic activity violate the commerce clause. In particular, the Court has repeatedly and consistently held that tax incentives that are restricted to transactions or businesses located in the granting state, and which thereby result in a comparatively heavier tax burden on interstate transactions or on interstate businesses, cannot survive the commerce clause's antidiscrimination standard.

While this case law has most commonly focused on protectionist measures that shelter local businesses from interstate competitors, many of the common types of location incentives provide precisely the same types of discriminatory advantages to those businesses that locate new economic activity within the state. Income tax credits or preferential deductions measured by, or conditioned upon, new investments or jobs located within the taxing jurisdiction appear particularly susceptible to the commerce clause's prohibition against discriminatory tax measures that give local commerce an advantage over out-of-state or interstate alternatives. Whether the Court will also extend the antidiscrimination standard to bar other forms of tax incentives, such as targeted property tax abatements or preferential rules for the apportionment of taxable income, raises more difficult questions of doctrinal evolution. Incentives provided by means of direct subsidies, rather than tax breaks, may be sheltered from commerce clause scrutiny by the market participant exception, although the Court's opinion in Camps Newfound/Owatonna v. Town of Harrison (1997) suggests that this "narrow exception" may be restricted to governmental involvement in a market in the role of buyer or seller, a characterization that does not naturally fit subsidy programs aimed generally at economic development.

Peter D. Enrich
(2000)

(see also: Interstate Commerce; State Regulation of Commerce.)

Bibliography

Bartik, Timothy J. 1991 Who Benefits from State and Local Economic Development Policies? Kalamazoo, Mich.: W. E. Upjohn Institute.

Enrich, Peter D. 1996 Saving the States from Themselves: Commerce Clause Constraints on State Tax Incentives for Business. Harvard Law Review 110:377–468.

Hellerstein, Walter and Coenen, Dan T. 1996 Commerce Clause Restraints on State Business Development Incentives. Cornell Law Review 81:789–878.

Herzog, Henry W., Jr. , and Schlottman, Alan M., eds. 1991 Industry Location and Public Policy. Knoxville: University of Tennessee Press.